Dollar struggles near three-year lows as Fed starts taper

The Australian dollar has gradually weakened, after a period of volatile trade that saw it briefly fall to its lowest level in more than three years as the US Federal Reserve started to wind back its unprecedented stimulus program.

The local dollar sank as low as US88.19¢ minutes before the Fed’s announcement on Thursday morning, before jumping more than a cent to US89.45¢.

It struggled to retain its strength as the day progressed, weakening to US88.38¢ in late trade.

Strategists said the Australian dollar was weighed down by a stronger US currency and tightening financial conditions in China.

INTERACTIVE GRAPHIC - DO NOT REMOVE

The Fed said it would trim its $US85-billion-month ($96-billion-a-month) bond-buying program to $US75 billion, with future reductions dependent on economic data. The Fed’s buying of mortgage and Treasury bonds were reduced by $US5 billion each.

Related Quotes

Company Profile

‘‘I’m not surprised to have seen traders initially mark the US dollar higher and the markets lower,’’ Westpac’s chief currency strategist Robert Rennie said.

But Mr Rennie said the statement was balanced by a clear indication from the central bank that it would continue to maintain a highly accommodative monetary policy as it closely monitored inflation and the unemployment rate.

The Fed added that it would maintain interest rates at very low levels until the jobless rate fall ‘‘well past’’ 6.5 per cent.

‘‘One section that really grabbed me when I read the statement was the use of the words ‘well past the time that the unemployment rate declines below 6.5 per cent’,’’ Mr Rennie said.

‘‘That’s a very important passage, because we know that the Fed has issues around whether the unemployment rate is a sign of strength in the economy.’’

The third-round of quantitative easing was launched by the Fed in September 2012 and involved buying $US40 billion in US government bonds and $US45 billion in mortgage-backed securities every month. The Fed’s balance sheet has reached $US4 trillion since it started quantitative easing in 2008 after the financial crisis.

The quantitative easing programs have seen ‘‘cheap money’’ support riskier assets such as the Australian dollar.

While the US dollar is expected to be moderately strengthened as the Fed continues to taper its asset purchases program, it could received another boost if the American economy performs more strongly than expected, NAB’s co-head for currency strategy Ray Attrill said.

‘‘If the economy actually performs as the Fed is forecasting, and you look at their own forecasts for the Fed funds rate, you’d actually say the market is underestimating the potential for rates to go up a little earlier than they expect and rise a little faster,’’ Mr Attrill said, adding that expectations of an earlier tightening of US monetary policy could further strengthen the US dollar.

‘‘We’ve only got the [Australian dollar] down to US84¢ at the end of next year, but I think the risks to that forecast are to the downside than the upside,’’ he said.

Meanwhile, tightening financial conditions in China, Australia’s largest trading partner, also pulled down the Australian and New Zealand dollars, RBS senior currency strategist Greg Gibbs said.

Mr Gibbs said Chinese rates were rising rapidly, with the one-year swap rate up by 25 basis points this week.

‘‘That’s a significant rise, and it concerns me. It concerns me on either — it’s going up and it could generate financial difficulties in China, or it could actually be telling us there are financial difficulties already,’’ Mr Gibbs said.

‘‘I want to be short the Australian dollar on the risk that turns out to be the case. I think that’s why the Australian dollar ... and New Zealand dollar is under pressure, even though it’s had strong [figures] this week.

‘‘The Fed is obviously getting a lot of press and getting a lot of attention and in some ways, I think it has been a bit of a smokescreen for the last quarter, whereas events in China may well be the driving influence on why this Australian dollar has been so weak.’’